Introduction to
Portfolio Management
Khader Shaik
Portfolio
• Financial Portfolio
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A collection of investments held as a group
Professional Institutions
Asset Management Corporations
Individual Investors etc
• Key objective
– Maximize the returns from the investments for given
level of risk
• Portfolio Management Involves
– Investing and divesting different investments
– Risk management
– Monitoring and analyzing returns
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Portfolio Valuation
• Performance is measured using
– Expected Return
– Risk associated with the return
• Portfolios are valuated using different
models
– Markowitz Portfolio Theory
– Modern Portfolio Theory
– Capital asset pricing model
– Arbitrage pricing theory etc
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Portfolio Management Key Factors
• Continuous P&L Calculations
• Portfolio may contain different classes of
products including derivatives
• Computing the RISK/Exposure is the key
• Incorrect pricing/valuation would expose
the Portfolio
• Incorrect Hedging would expose portfolio
• Most Portfolios are rebalanced almost
everyday
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Factors affect the P&L
• P&L Changes from the RISKs that were
unhedged
• P&L Changes from the usage of imperfect
Hedging Model
• P&L Changes from new trades during the
day
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Derivative Product Types & Exposure
• Linear Product
– Price of the product is directly dependent on
the price of the underlying asset
– Hedge the product and forget
• Non-linear Product
– Price of the product is not directly dependent
on the price of the underlying asset
– Rebalance the Hedge as frequent as
necessary
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Risk Management
• Risk
– The chance that an investment’s actual return will be
different than expected
– Actual return may wipe some or total original
investment
• Risk and Reward
– The greater the amount of risk, the greater the
potential return
• Categories of Risk
– Market Risk
– Credit or Default Risk
– Operational Risk
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Market Risk
• Market Risk – risk caused by the movements in
the market factors like
– Interest Rates
– Stock Prices
– Exchange Rates etc
• Market Risk is usually measured by
methodology referred as “Value at Risk” (VaR)
• What is meant by Measuring Risk
– The probability of adverse circumstance happening
– The cost of such adverse circumstance
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Credit Risk
• Risk of non-payment of interest and/or
principal by borrower
• Financial health of the borrower is the key
factor
• Lenders measure borrowers financial
health using different methods
– Credit Rating
– Credit History etc
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Credit Risk
• Risk of non-payment of interest and/or
principal by borrower
• Financial health of the borrower is the key
factor
• Lenders measure borrowers financial
health using different methods
– Credit Rating
– Credit History etc
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Operational Risk
• Risk of loss caused by inadequate or
failed internal process, people, system and
external events.
• Operational Risk Management
– External Regulatory Agencies
– Internal compliance and risk management
departments
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VaR – Value at Risk
• VaR is used to measure a Market Risk of
an Asset or Portfolio of Assets
• It is single number that summarizes the
total risk in financial portfolio or asset
• It answers the question
– How bad things can go wrong?
• For example if VaR of a Portfolio is $2M,
at 95% for 1 day
– 95% sure/confident that in ONE day portfolio
cannot lose more than $2M
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